Monday's Reversal Sets U.S. Equities Up For Selling

Market Recap for Monday, February 25, 2019

If you looked at the final numbers yesterday, you'd probably think it was just another day in this two-month long advance, but it wasn't just another day. It was a reversal off a gap higher with the market initially reacting to positive fundamental news. It looks to me like market makers finally took a short position, selling their shares throughout the day. We're also very overbought, so I'd expect to see further selling this week.

Most U.S. indices finished with gains on Monday, led by the NASDAQ's 0.36% rise. One notable exception, however, was the small cap Russell 2000, which finished with minor losses (-0.08%). It was also a rare day when small caps underperformed their larger cap counterparts, the benchmark S&P 500:

Small caps' relative strength in February is highlighted on the chart above, but we did see a possible top where we also saw relative reaction highs in October and November. I'll be watching to see if there's a short-term shift back towards larger cap stocks during a period of consolidation or selling.

There was one clear positive from Monday's reversal, however. The leadership to the downside was defensive stocks. Real estate (XLRE, -0.83), utilities (XLU, -0.65%), and consumer staples (XLP, -0.55%) were the primary casualties. The former saw a bearish engulfing candle print on Monday with a negative divergence in place, a rather ominous combination:

In addition to the slowing price momentum, it's also noteworthy that volume completely dried up on the XLRE's last attempt at a breakout. That suggests slowing momentum as well.

Materials (XLB, +0.65%) led all sectors, continuing its hot February and perhaps influenced by the dollar (UUP), which has struggled the past 7-8 trading sessions since posting a fresh 2019 high.

Pre-Market Action

U.S. futures look to extend the selling that we saw throughout much of Monday's session. Dow Jones futures are down approximately 100 points after Home Depot (HD) reported quarterly results that fell short of expectations and delivered weak guidance. Caterpillar (CAT) was downgraded by UBS Securities to add more bearish fuel to the fire.

A continuing anchor for the stock market is the 10 year treasury yield ($TNX), which is down 4 basis points this morning to 2.63%.

Equities were down in Asia last night and are down this morning in Europe.

Current Outlook

While the majority of "under the surface" signals point to higher equity prices ahead, the bond market and the relative performance of transports vs. utilities ($TRAN:$UTIL) are two that would suggest otherwise. Equity prices, rather obviously, move higher when prospects for higher earnings are apparent. The stock market is always looking forward. In an improving economic environment, investors typically overweight equities and underweight bonds. This results in higher treasury yields as proceeds from the selling of bonds are reinvested in equities. But during the stock market's impressive rally off the December lows, the 10 year treasury yield ($TNX) has barely budged off its January low. Hhhhhmmmmm.......

Secondly, during economic expansion, transports generally perform well as a stronger economy requires that more goods be shipped. And utilities typically struggle as higher yields persuade income investors to pursue treasuries, which provide more safety. Therefore, we normally see a rising $TRAN:$UTIL ratio to confirm a rising equity market. But check this out:

This ratio remains in a down channel and, at its recent high, printed a negative divergence (pink lines). I look for PPO centerline and 50 day SMA tests after a negative divergence prints. For those in the bullish camp, this ratio needs to break above the upper downtrend channel line.

Sector/Industry Watch

The Dow Jones U.S. Hotels Index ($DJUSLG) has gained more than 14% in the past month, ranking it as the best performing consumer discretionary industry group and one of the best performing industry groups overall (tobacco has been the best at 18%). Like many areas of the stock market, however, it's very overbought and Monday's candle suggests that consolidation is at hand:

At this point, and until proven wrong, I'd only look for an overbought pullback. Bullish price momentum is still accelerating, which suggests to me that a rising 20 day EMA test is the most downside I'd look for. The late November high was roughly 1880, so selling to test that level would also make technical sense.

Historical Tendencies

Over the past 20 years, Apple, Inc.'s (AAPL) best calendar month performance has occurred during February where AAPL has averaged gaining 6.2%.

Key Earnings Reports

(actual vs. estimate):

(all are estimates as Zacks has not updated actual earnings this morning)

Key Economic Reports

December building permits released at 8:30am EST: 1,326,000 (actual) vs. 1,290,000 (estimate)

February Case-Shiller HPI to be released at 9:00am EST: +0.4% (estimate)

December FHFA house price index to be released at 9:00am EST: +0.4% (estimate)

February consumer confidence to be released at 10:00am EST: 125.0 (estimate)

Happy trading!

Tom

About the author:Tom Bowley co-founded Invested Central and served as the site's Chief Market Strategist for more than 10 years.
His unique trading style combines both his fundamental and technical strategies to systematically manage risk while trading.
A regular contributor to StockCharts.com's bi-weekly ChartWatchers newsletter since 2006, Tom's role at StockCharts has expanded significantly since he joined the company as a full-time Senior Technical Analyst in March of 2015.
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